As highlighted in reports passim, the summer Natural Gas strip (Apr’10 to Oct’10) is trading at a significant premium to the nearby winter strip (Nov’09 to Mar’10). For this point in the season that is odd. We could expect this contango in October, when the first leg on the winter strip approaches expiry, but to see this behavior so early in the year is, to quote everybody’s favorite Vulcan, highly illogical.
The first two weeks of March this year have seen an average ratio (Winter/Summer) of 0.952 while the 03-08 timestep averaged 1.176. Such a stark difference is far beyond statistical anomaly. Last year saw the spread widen 2.3% over the month of March, meaning the winter strip gained strength relative to summer.
Can we expect a similar recovery this year? The technical indicators point to no. In today’s issue of we graph the Winter/Summer ratio along with the Relative Strength Index (RSI). The RSI is interesting because it tests the recursive strength of the position against itself, which is useful when a contract detaches from normal relationships and patterns, as we’re seeing this year.
Another useful measure is the Hilbert indicator, brought to prominence by John Ehlers in his book “Rocket Science for Traders”,which attempts to map the cyclical time between peaks and troughs. If we consider the 25th April low of 0.936 as a trough, the Hilbert indicator for that date is 17 days, meaning the contract was expected to peak on May 14th and fall thereafter.
In fact, May 13th hit 0.963 before falling to 0.956 on close of Friday. What was the Hilbert Indicator on Wednesday? 29 days, implying that the summer strip is expected to retain strength relative to winter over the coming weeks. Of course, day by day fluctuations are inherent, but the indicators conform with the downward linear trend we’ve seen to date. Mean reversion and technical trades thrive on volatility, the more erratic the market the more entry and exit opportunities. The contracts individually have a lower volatility this year compared to the 03-08 timestep, but the ratio is actually more volatile due to the prices being less correlated to each other this year. Thus the cross-seasonal trade is more suitable for technical trading than either strip individually.
We are all aware of the extant purge in North American rig counts. To wit, the EIA expects total U.S. marketed natural gas production to drop by 1.0% in 2009 and by another 2.8% in 2010 in response to poor drilling economics. On the other hand, poor economic demand in Asia and Europe, new liquefaction capacity and limited natural gas storage capacity in countries that typically rely on LNG are anticipated to increase the availability of LNG for the United States. In other words, non-conventional domestic natural gas plays plus stranded LNG set the table for further weakness… and the NYMEX forward curve reflects this scenario.
The bottom line is for the last 10 years we’ve seen the winter contract trade at a premium to summer, anything else would be crazy. This year, demand is so weak relative to supply that a contango has taken hold.
We shouldn’t sit back and wait for prices to snap back to backwardation - strong arbitrage opportunities still exist for those willing to think a little illogically.
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Stephen Schork is the Editor of, and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.